Tuesday, July 31, 2012

The Department of Energy released its monthly update today on natural gas production and prices through May, and the chart above displays inflation-adjusted natural gas prices for commercial and industrial users. By end user in May, industrial customers represented about 32% of natural gas consumption and electric power companies used almost half (49%) of the total natural gas consumed. Together, industrial and electric power customers consumed more than 81% of the total natural gas supplied in May. The rest of the natural gas market is split between residential customers (10%) and commercial users (9%), with a small fraction (1/6 of 1%) going for vehicle fuel.

On an inflation-adjusted basis, the prices paid by industrial users for natural gas in May were the lowest since at least January 2001, when the Department of Energy's monthly data series starts (see red line in chart). The prices paid by electric power companies are almost identical to the prices for industrial users, so we can conclude that the users of more than 81% of the natural gas supplied in May (industrial customers and electric utilities) were paying the lowest, inflation-adjusted gas prices in at least a decade, and possibly longer. Prices paid in May ($2.94 per 1,000 cubic feet) were less than half the natural gas prices of two years ago in March 2010 ($6.31), and about one-quarter of the $13.62 price four years ago in July 2008.

Likewise, commercial customers are paying inflation-adjusted natural gas prices that are close to the lowest in recent history, and about half the 2008 price (see blue line in chart).

These significant price declines for industrial, commercial and energy power users provide additional support for the claim that America really "hit the energy jackpot" with the "natural gas windfall," making it "one of the most important developments for the U.S. economy in the last 60 years," according to Martin Neil Baily and Philip Verleger in a recent CNN editorial, here's an excerpt:

"Cheap gas may not be enough to offset the drag of a slowing global
economy this year, but it will boost long-term investment, help the
beleaguered manufacturing sector and increase exports.

Building petrochemical plants could suddenly become attractive in the United States. Manufacturers will "reshore"
production to take advantage of low natural gas and electricity prices.
Energy costs will be lower for a long time, giving a competitive
advantage to companies that invest in America, and also helping American
consumers who get hit hard when energy prices spike.

After years of bad economic news, the natural gas windfall is very good news. Let's make the most of it."

U.S. manufacturing companies (chemicals, metals and industrial)
could employ approximately one million more workers by 2025 because of
abundant, low-priced natural gas.

Lower feedstock and energy cost could help U.S. manufacturers reduce
natural gas expenses by as much as $11.6 billion annually through
2025.

MP: As I have emphasized lately, America's ongoing shale-based energy revolution is one of the real bright spots in an otherwise somewhat gloomy economy, and provides one of the best reasons to be bullish about America's future. The shale revolution is creating thousands of well-paying, shovel-ready jobs in Texas, North Dakota and Ohio, and thousands of indirect jobs in industries that support the shale boom (sand, drilling equipment, transportation, infrastructure, steel pipe, restaurants, etc.). In addition, the abundant shale gas is driving down energy prices for industrial, commercial, residential and electricity-generating users, which frees up billions of dollars that can be spent on other goods and services throughout the economy, providing an energy-based stimulus to the economy.

Cheap natural gas is also translating into cheaper electricity rates, as low-cost natural gas displaces coal. Further, cheap and abundant natural gas is sparking a manufacturing renaissance in energy-intensive industries like chemicals, fertilizers, and steel. And unlike renewable energies like solar and wind, the natural gas boom is happening without any taxpayer-funded grants, subsidies, credits and loans. Finally, we get an environmental bonus of lower CO2 emissions as natural gas replaces coal for electricity generation. Sure seems like a win, win, win, win situation to me.

We read, But today Exxon, the prototypical oil giant, gets about 50% of its production from, and has 50% of its reserves in, natural gas...., and "Since the acquisition, XTO's proven shale gas reserves have increased 81%, through a combination of strategic acquisitions and development of existing acreage, to 82 trillion cubic feet -- enough to meet demand in the Dallas-Fort Worth area for 150 years. "Exxon made a bet on natural gas, and so far they are underwater, because the price of gas in the U.S. has collapsed," says Fadel Gheit, the longtime Oppenheimer energy analyst. "That doesn't mean that they are wrong, because their investment horizon is not the same as Wall Street's.""

Now anyone who has been paying attention knows that the majors have a shrinking reserve problem that will punish them some time in the future. How do you avoid this problem? Well, you buy shale gas, use the 6:1 energy ratio conversion even though the price ratio is closer to 30:1 and assume high EURs that cannot be justified by the production data. Because your revenues are mainly from conventional sources and you have plenty of cash flow there is no need to worry about losing money on shale production.

The problem that you have are the companies that do not have such conventional production assets to muddy the waters. A company like Encana, which sold off its oil assets so that it could concentrate on gas, had to write down its money losing shale leases. Others will follow. Eventually the SEC will ask Exxon why it is not doing the same thing given the fact that it has exactly the same issues as the other companies in that space. I imagine that when that day comes Tillerson will have either retired or be quickly on his way out. And fools who have refused to see reality as it is will try to blame him and the analysts for their own inability to be objective and think for themselves.

Another alarm bell is going off. If hot weather and the closing of coal plants can't get the price high enough for the shale producers to make a profit how are the going to be able to stay in business or get more financing to stay afloat?

Interesting that they would continue at their present pace don't you think?

If you were the CFO of 'BIG' Oil Co. and the President and Dems were pushing to end your tax breaks, how would you play it?

That depends on the goal. If I were hoping to hide the decline in reserves I would buy a shale gas company and use the 6:1 energy equivalency ratio along with high EURs to fool the markets for as long as I could. As I did that I would be looking to purchase companies that have actual reserves that are cheaper to acquire in the stock market than by exploration, particularly when I could use my overvalued paper to pay for acquisitions. When the whole scam falls apart I would expect that the peak oil reality would drive my share values higher again even after having to write down the shale assets.

In a way, that may be what Exxon is doing because I can't see its management being that stupid or naive.